Calculating revenue streams consisting of monthly or other periodic charges is in theory very straightforward: customers pay a regular fixed fee. However, calculating these charges correctly is a challenge, as projections involve using usage or retention assumptions that are difficult to incorporate correctly.
Let’s start from one of the most common revenue types for startups: subscription fees, which is only likely to further expand in the future.
After analysing, sizing the market and projecting customers, you should have the following figures for every month or year of your expansion: number of customers reached, number of new customers and number of active customers. This distinction makes the calculation of subscription fees tricky, as we should use the number of active customers to calculate this revenue stream, meaning after incorporating a retention rate. I tend to calculate the number of active customers for the entire business, using a retention rate that applies to all revenue streams. For this reason it is recommended to keep the retention rate rather high and consider lost customers as those that are unlikely to return, while incorporating the specific retention rate of subscription fees by using each subscription’s duration.
The main figures and assumptions needed to calculate subscription revenue are:
- The Portion % of your total active customers that will buy subscriptions.
- The type of subscriptions that you plan to offer and their duration as well as how often you charge your customers. If you have discounts for yearly payments, it may be better to set it as a separate subscription type with a different price in your financial plan.
- Customers split % with the portion of subscription customers who will buy each type of subscription. For subscription fees, the sum should be 100%: it certainly cannot be less than 100%, but it is also unlikely that a customer would buy multiple subscription fee packages, except in few circumstances.
- Unit price of each subscription, monthly or yearly depending on the financial plan setup, as well as any price inflation over the years, or a price jump after the beta phase.
- Duration of each subscription, which should be accounted for in the calculations as not all active customers will buy 12 months of subscription. Additionally, some subscription fees are paid monthly and some yearly. There are two ways of doing this: you can set payments directly when they occur buy using more complex formulas in the revenue calculation, or you can set a weighted average monthly subscription fee charge based on the assumptions above, and then calculate an average days of receivables to calculate cash flows correctly. When calculating revenue for accounting purposes, it is usual in most countries to recognise revenue when a subscription is sold, and make cash flow adjustments later to receivables, prepayments and unearned revenue.
Directs costs to subscription revenue is instead quite easy to calculate, typical costs would include: